Investing Is Easy – Doing It Well Is Hard

We’re in the money! Or are we? For the lucky – or prudent – New York co-op with multi-million-dollar capital reserves, keeping that sum intact and shareholders happy brings its own unique set of problems. The booming real estate market of recent years saw some co-ops converting commercial rental units into additional shares and selling them while others acquired large sums via flip taxes. Whatever the reason, the cash accumulated quickly, and it’s now up to the board to make maximum use of those funds.

What’s the first step? “There is a need for an investment policy statement voted on by the co-op board so they know what the limitations are,” says Michael Kelley, a financial advisor and former treasurer of a Manhattan co-op, who currently advises three separate co-ops whose combined invested assets total $18 million.

Not thinking this through can lead to severe losses. If the return is too small, even a little inflation can quickly erode the value of the accumulated cash. A sudden rise in interest rates after locking into a small return for a long period is lost income. Betting on the stock market can post the highest returns of any asset class but also carries the most inherent risk.

However, given that the objective of most co-ops is keeping principal intact, that last option is usually ruled out. “They can’t go out and play the stock market since the goal is not to put the co-op’s money at risk,” observes Gerard J. Picaso, president of Gerard J. Picaso Inc., which manages 48 buildings across Manhattan and Queens.

After determining investment policy, the next step is to find the right adviser. Some boards have a powerhouse of accountants, money managers, and financial specialists already at the table. But other boards may lack such specialist expertise and have to hire outside help. Some even prefer they be given external advice since that can help prevent conflict of interest and/or bad judgment from other shareholders.

Tim Ghriskey, chief investment officer at New York-based Solaris Asset Management, which oversees $2 billion in assets, says, for assets of several million dollars, a co-op board’s first call, after setting the objectives, should be to an institutional size consultant.

“With several million to invest, you find a consulting firm that, for a small fee, will direct you to an investment manager and then monitor the manager,” Ghriskey says. “The manager will then select an allocation of cash, bonds, and equities.”

Ghriskey and Kelley both suggest erring on the side of caution and investing in low-risk securities, generally known as fixed income, that pay a specific interest rate or yield. Those securities are typically bond or money market instruments. “Investments are great if they go up, but everyone will scream if they go down,” says Ghriskey.

How can a co-op expect to do investing in low-risk assets? Checking historical performance back to 1925, inflation has been running at about three percent a year, Kelley says, with 90-day treasury bills returning 3.7 percent per annum and long-term government bonds 5.4 percent. An all-fixed-income portfolio then has an average return of 4.5 percent over the long term, or 1.5 percent over the inflation rate. While that pales next to the 10.4 percent return on large-cap stocks over the same time frame or the 12.7 percent for small-cap equities, fixed income is the safe play for investing the cash.

Adds Ghriskey: “You can do better than the money market or certificates of deposit [CDs] by actively managing the money rather than placing it in several securities and leaving it there.”

Ghriskey’s firm would charge 1.25 percent of the assets per year to manage the money for investments of $1 million to $5 million in their commingled account, 1.0 percent for a $5 million account held separately, and 1 percent a year scaling down for invested assets above $10 million.

Kelley notes that 95 percent of the $18 million on which he advises is in some type of fixed-income investment. But because of the fee structure and the expected return, the smallest fixed income account that would make sense is about $2 million. If it was all in equities, the minimum investment could be as little as $25,000, but, again, that higher potential return involves sharply higher risk.

One co-op with money to invest is the 1,850-family Windsor Park Owners Corp. in Bayside, Queens. Larry Kinitsky, president of the co-op, describes their reserve as “several million dollars” after keeping two months, operating expenses on hand. The co-op began seriously investing its reserves three years ago when it got to “a significant amount,” Kinitsky says. They amassed their funds in part through selling off non-core assets such as wireless antenna rights.

Taking advice from Shearson, one of two outside advisors recommended by its managing agent Akam Associates, the co-op only invests in accounts where the security of the principal is guaranteed by the government’s Federal Deposit Insurance Corporation.

“We’re on a program of laddering CDs,” Kinitsky explains. “Though they may be with different banks, the maturities are staggered from three to twenty-four months. If one comes due and we don’t need the cash, we roll it back in. But we always have some money coming due every three months.”

That approach enables them to have liquidity and increase the money over the long term, says Kinitsky, who adds that their portfolio yields a little over five percent per annum.

The investment philosophy of prudence and caution is continually explained to shareholders, and no one complains about the limited returns. “You can have a year like 2000 where you have $5 million one day, but, with a bad market, you wake up with $2 million,” Kinitsky notes.

Although it was narrowed down for them, Kinitsky’s board still selected its final advisor through an interview process. “It is no different from the individual level,” Kinitsky says. “You look for a guy you are comfortable with at a fair price.”

Another important question is what amount of cash should be invested and what should be held readily available. Some co-ops may have reserve requirements written into their bylaws; others may just want to keep about six months of operating expenses on hand.

“The strategy is based on when the money will be needed,” says Dan Wurtzel, chief operating officer at Cooper Square Realty, which oversees 150 buildings. “How liquid does [the reserve] need to be? Are there capital projects coming up?” Recommending a mix of high-interest money market investments and CDs, Wurtzel says that maturities should be staggered with some investments always being paid out as cash. If the funds aren’t needed, they can be reinvested. But he also chants the mantra of low risk. “The board has a fiduciary duty to minimize the risk,” he says.

There are also tax implications that may bear on the size of the reserve, says Abe Kleiman, a partner at Kleiman & Weinshank, a certified public accounting firm providing accounting, auditing, and tax services to co-op and condo associations. Kleiman says a co-op should undertake a study of future repairs to the building’s components, such as elevators, roof, and boiler, and estimate what the replacement cost could be – essentially a 10-year capital budget.

A newer building may have almost no estimated costs for future repairs while a 50-year-old building could have a large estimated outlay, Kleiman adds. The capital budget will help justify the income earned on any reserve investments as part of the co-op’s general revenue stream, to be offset by the property’s general expenses.

Problems can arise if the reserves are deemed excessive and the argument made that its purpose is to generate additional funds. That income, known as non-patronage income, will be dealt with separately from the co-op’s main sources of income, such as maintenance and possibly rent from a commercial space.

While expenses related to earning that non-patronage income, such as the fees paid to an advisor or portfolio manager, can be deducted to offset taxes, none of the building’s general expenses can be used to offset any tax liability. If, in either case, the income was large enough after expenses to be subject to tax, a co-op may want to consider tax-exempt investments, such as municipal bonds, for the reserve fund.

And if your co-op is not among the fortunate few with a couple of million to spare, it can still be a good idea to get an investment mandate and strategy in place to maximize the return on the funds you do have, thereby placing the co-op on a firmer footing for the future.

Georges Mosse, president at 160 Columbia Heights, a Brooklyn Heights co-op, says that the corporation’s reserve is not large. Nonetheless, it still invests funds through the co-op’s bank into the money market or government treasury bills with a maximum maturity of 30 days. But, keeping one eye on the future, he already knows what the next phase will be. “As we build funds, it will be a question of investing for six months to a year.”